Monday, October 29, 2007

For years now AMD (AMD) and Intel (INTC) have been slugging it out in the microprocessor market. The next arena for this slugfest is virtualization, the process in which a single computer can run multiple instances of an operating system, or even entirely different operating systems (typically Linux and Microsoft).

Intel has been the dominant player in the microprocessor industry since the 1980s and still dwarfs AMD. But AMD gained a great deal of market share earlier in the new millennium with its Opteron and Athlon processors. Unfortunately it did not gain enough to prevent Intel from having a comeback in 2006 that has extended up until at least now. The main cause of AMD's insufficient gains during a period of time when it processors outperformed Intel's on any basis was human nature. Most businesses had standardized on Intel processors; many did not even consider taking advantage of the AMD proposition. I think a lot of this was influenced by the broad ownership of Intel stock among key decision makers, but I can't prove that without doing some costly research.

The question for those owning AMD stock (including me) and those rare people considering buying it should be: what will happen in Q4 2007 and in 2008. This will be highly dependent on the new quad core Opteron processors (code named Barcelona) and their virtualization features.

There are plenty of technical articles being written on virtualization and on AMD's and Intel's versions of it. The reality is, however, that until there have been a number of large-scale commercial installations that use virtualization 24 hours a day for long periods of time, we won't know if one design is superior to the other.

Virtualization seems like no big deal on a desktop or notebook computer. It is basically making possible in software what used to be done, in a clunky way, with a hard disk partitioned between two operating systems. Now using VMware or other virtualization software both operating systems can run at the same time, sharing the microprocessor, memory, and network bandwidth.

But according to Rackable Systems, making a server farm work well with virtualization is not so trivial of a task. Server farms already have issues with interconnecting all of their computers. There is an issue called load balancing: if you are, say Amazon (a Rackable client) and have thousands (or millions) of people searching your gigantic Web site all the time, and the Web site has to be coordinated with a database and a shipping system and a content management system, well, in non-tech speak it gets hairy. A virtual operating system sitting idle is just a waste of expensive equipment.

Rackable has a new line of servers ready for introduction that are engineered from the ground up for virtualized server farms. Probably IBM, Dell, Sun and HP are working on this issue too and will make their claims.

It will sure be interesting to see if this virtualization-ready line is available in only one flavor, AMD or Intel, or if it available for both.

Another area of interest in the AMD versus Intel battle is processors for notebook computers. In this area I see pundits constantly reporting that AMD cannot possibly compete. Yet it seems like every quarter AMD picks up a bit of market share in notebook computers. Partly this is because Intel started with so much market share and does have good notebook technology. Intel likes to charge its customers through the nose when it has no competition (hence accusations of monopoly pricing). Surprise, most people don't feel like they can pay $2000 for a notebook computer that will be broken on obsolete in 2 years. People really like computers to be in the $500 to $700 price range, and to make a profit in that market many notebook computer manufacturers have turned to AMD. With AMD readying a new line of notebook-optimized microprocessors, motherboard chips and graphics chips, it is possible that it may gain even more market share in 2008.

I consider investing in AMD to be a risky business. Investors should always balance the risks in their portfolios by diversification.

Sunday, October 28, 2007

Rackable Systems (RACK) reported Q3 2007 results that showed a second quarter of good revenue improvement and brought the company back from serious losses to break-even. Management reported that at the end of the quarter the backlog of orders had reached a record high. And just in case the analysts covering the conference missed the point, Rackable named the four customers that buy the most equipment from them: Microsoft, Yahoo, Amazon, and Facebook.

Before looking at Facebook and other opportunities, recall that RACK stock has been very volatile (See chart at NASDAQ). In the past 18 months it has been over $50 and as low as $11.25. The highs were reached after Rackable ramped up its highly efficient server system sales in the previous few years. The lows came after bigger server-market players took notice and started low-balling bids on systems, causing Rackable to lose sales and to lose profit margins on some sales that took place (See Rackable, Playing With the Big Guys, April 5 2007). Rackable had to restructure and write off inventory as obsolete. So in 2007, Q1 saw a plunge in revenues and heavy losses; Q2 saw a sequential increase in revenues and heavy losses; and Q3 saw a second sequential increase in revenues and break-even on earnings.

So where do we go from here if we take a ride with Rackable? (Note that I own stock in the company.) It depends on how well Rackable does against its competition. Rackable pioneered energy-efficient server farm designs, but its equipment is not the cheapest on the market. Its servers are easy-to-manage, and it now has some new, very innovative products. One is that is has a line of servers optimized for virtualization, which is a big industry trend. It also has ICE Cube, what might be called a server-farm in a box. These are your basic cargo containers filled with servers. You can buy a server farm ready to go and just put it in the parking lot; there is a lot of interest, and only one other company is trying to compete in this space so far. Once built an ICE Cube server farm uses far less energy than a conventionally warehoused system.

Another boost going forward will further enhance Rackable's reputation for being the leader in Green computing (their slogan is "Enabling the ecological datacenter") is the release of new server systems using AMD quad core Opteron processors. Rackable started as an AMD-only company, then added lines using Intel processors that became substantial over time. Conservative customers, and IT departments whose decision makers own Intel stock, still have Intel-only buying policies. But management confirmed that demand for AMD quad-core based servers is high and systems will be shipping this quarter (I am guessing that is the reason for the record level of backorders). The AMD chips are better designed than the Intel chips and so deliver more overall computing power with less energy consumption.

It is interesting that Google is not a Rackable customer. As the largest Internet company, you would think it would be in there with Microsoft, Yahoo, Facebook and Amazon. Google succeeded in part by stringing a lot of cheap servers together with their own proprietary methods. I'm betting those servers are very un-Green, very energy inefficient, but for now Google is so profitable it probably is not concerned much about its electric bill.

Facebook suddenly has a bunch of cash from Microsoft's buying a part-interest, so don't be surprised if they use some of it to build out their server farms. Microsoft has announced plans to greatly increase their Internet presence, so they will be expanding their server farms as well. And Yahoo and Amazon are expanding too, if not quite at Google's pace.

So I think Rackable systems has a good chance of being an emerging success story in 2008. However, you should be aware that the stock is risky. Rackable is planning on spending a lot of money on expansion; in the short run that will mean even if revenues ramp up, earnings may be negligible. Rackable is playing against formidable competitors like Sun, HP, Dell, and IBM, so they are not guaranteed to win.

Tuesday, October 23, 2007

It has been a busy couple of weeks for me. I've thought of doing blog entries on Biogen-Idec (BIIB), AMD, and Gilead (GILD), but have not found the time. I still have one more installment in my Picking a Biotechnology stock series (but I went ahead and bought Gilead). But I think the most interesting, untold story is about Anesiva.

I would not know about Anesiva (ANSV) except that I invested in a stock called Corgentech a few years ago. At the time Corgentech was having problems with it drug development program, but had a great deal of cash left over from its stock offerings of more optimistic times. A different company, focused on pain drugs and funded by venture capitalists, was looking for a stock listing and more cash for its development plans. The two companies merged and the new company was called Anesiva. This was in 2006.

Anesiva's most advanced therapy was for reducing the pain a blood draws. It was actually a simple idea: take a well-known safe and effective drug, lidocaine. Make it into a fine powder and put it in a single-use device that uses a puff of gas to embed the powder in the skin in a circular patch. Within about 1 minute the skin is numbed. The patient feels little or no pain when blood is drawn or an IV needle is inserted. The treatment is now called Zingo.

Back then most analysts dismissed Anesiva with the belief that it would not get approval for Zingo from the FDA. They argued that even clinical studies proved Zingo to be safe and effective, the FDA just was not keen on pain killers. They pointed to a record of failure of other pain drugs to be approved by the FDA. I think the real problem for the major brokerage-connected analysts was that Anesiva did not do an IPO, so no one prestigious had got the fees that induce Wall Street to hype companies to investors.

The Phase III studies of Zingo came in with impressive results. The first studies were done for the "pediatric market," which is to say for children. National health guidelines have been adopted to reduce pain and anxiety for children in medical settings. The FDA not only approved Zingo for children; it approved it early. Even Anesiva seemed surprised.

And the stock price is, yes, down. As far as I know, no major brokerage house recommends Anesiva stock. The consensus now: no one is going to pay $15 to save their child from pain, and even if the parents would, the HMO's won't.

But HMO's are only careful with money, not stupid. Time is money, and getting kids to accept procedures without a struggle saves staff time. It also means happier customers.

Anesiva is working to get high-volume production of Zingo units underway. They have a sales staff that is working on getting hospitals to adopt the therapy. There is a group of pediatric nurses that is tired of being seen by children a harbingers of pain. The nurses are advocating for widespread use of Zingo for children.

Commercial sales of Zingo probably won't start until Q2 2008, and like all ramps, may get off to a slow start. Meanwhile the Zingo Phase III trial for adults has been completed with good results. It will take a while for Anesiva to submit the data to the FDA, but approval for use with adults should come in 2008. In this kind of situation we have what is called a label-expansion. All the FDA needs to do is say that what can be given to children can be given to adults.

Just based on the Zingo story, Anesiva is a very undervalued stock. But there is another drug in the pipeline. It is called Adlea and it is used for surgical pain. Basically, Adlea is sprinkled in the affected area during surgery. It appears to relieve pain for 6 to 8 weeks after that. I am guessing that eventually it will become a standard surgical procedure. Because of the way the FDA works, you can't just ask for approval for surgery in general. Anesiva has been trying it out on a variety of procedures, notably knee surgery and bunion surgery. The great thing about Adlea is that is can reduce the need for full-body opioid painkillers. I think the FDA likes that idea.

Nothing is guaranteed in the stock market, but Anesiva is a pretty good bet. Even if the big brokerage houses delay a long time before recommending it, in the next two years sales are highly likely to ramp up and away.

As always, there are all kinds of risks, including the possible failure of doctors to adopt a new therapy. Anesiva, like any stock, should only be held a part of a portfolio balanced for risk.

Again, most sell-side analysts don't like Anesiva. Every time they have been proven wrong, they just find another reason to not like it. That is the main reason the stock price is such a bargain now.

Tuesday, October 9, 2007

The stock price of Microchip (MCHP) dove over 10% this morning following yesterday's after-hours Q3 revenue warning by the company. I already owned Microchip, so of course I was disappointed. But my portfolio model allows me to buy more of this stock, which pays a substantial dividend. I consider it to be the safest stock in my portfolio because it pays a very substantial dividend for a technology stock. At a price of $32.77 the current yield is 3.6%, which is a bit less than you can get on a 90-day treasury bill right now.

If you read my analyst conference summary for Microchip's Q2, you will see that management's guidance for Q3 was "September quarter revenues expected flat to up 2%. GAAPEPS $0.36; non-GAAPEPS $0.39. " Q2 revenues were $264 million, up from $258 million in Q1.

The warning today stated Q3 revenues will come in around $258 to $259 million, or back to Q1 levels. GAAPEPS is estimated at $0.35 and non-GAAP (which excludes stock-based compensation) will be around $0.38.

So now Microchip is saying it will miss its earnings guidance by one penny per share. Hardly cause for an over 10% price drop on a stock with a high dividend yield.

On the other hand, I had predicted a good Q3 because I believe manufacturers who use Microchip'smicrocontrollers have been overly cautious about inventory levels and their own final demand. I still think that, because there are stories circulating of microcontroller-based devices like toys (these may be microcontrollers from other manufacturers) not being ready to meet holiday demands. It is lost money all around if stocks are insufficient to meet consumer demand.

Of course I like making more than 3.6% on my investments. Microchip has steadily increased its dividend over the years, so expect more in the future when the demand constraint disappears. I think the stock has considerable upside potential, dependent of course on revenue and net profit increases in future quarters. And compared to the much more risky biotechnology and technology stocks I tend to invest in, Microchip is a no-brainer for my portfolio.

Wednesday, October 3, 2007

I have been watching SAN (Storage Area Network) equipment maker Dot Hill (HILL) closely lately, hoping Q3 would be the day this company showed traction. The stock is cheap, the company has quite a bit of cash compared to its market capitalization value, but this only will work out for investors if revenues and earnings start a steady increase. (I don't hold Dot Hill, but have in the past).

Hopes were dashed today by a preliminary Q3 earnings report. Instead of getting traction, revenues were down quite a bit. The estimate is $43 to $46 million, a plunge of at least $10 million from Q2, and at least $4 million below the low end of the guidance given by management in August.

The only bright bit of data is that cash may have increased slightly. The company has been taking steps to cut costs.

Dot Hill has been trying to get away from being a parts source for a single customer, Sun. It has made good progress on that score in the past year. It is not clear whether the Q3 shortfall is due to lack of orders from Sun, or a gap in orders from one of the new customers. In any case sales to new customers cannot be ramping very quickly when we see this kind of result. Dot Hill has some impressive new technology, but competition in the data storage industry is fierce.

For more information see my Dot Hill page, which has links to my notes on prior Dot Hill analyst conferences.

Monday, October 1, 2007

What about Sepracor (SEPR)? Isn't Sepracor a lot less of a risk than Gilead, with just about equally good growth potential?

(Meanwhile, since #2 of this series on September 10, saying Gilead would become my default choice if I could not find a better biotechnology investment, Gilead stock has gone from $37.50 to $41.87 per share. Then again, the market in general is well up.)

I have not followed Sepracor closely these last few years, and there is a history to that. Back in the slump in 2002 I bought some Sepracor for $5.06 per share because I thought the price was ridiculously low. In April of 2003 I thought the price had gone ridiculously high, so I sold it at $17.07 per share. It was one of my best trades ever. Imagine how dumb I felt as the stock continued to climb. By 2004 it went over $50 per share.

Sure it was a good company, with a good strategy for developing marketable drugs, and it already had approved drugs and revenues. But I thought the people who bought it at $50 per share were taking an astonishing risk. In my eyes it would take years of increasing sales revenue and net income growth before such a high price could be justified. The price peaked at over $65 per share in early 2005.

But today I can buy the stock for $27.41 per share, and maybe I should. But my experience illustrates an important point about stock speculation: there is a lot of pure chance and investor psychology involved. The idiot who bought my stock for $17.07 per share, even holding it until today, has done fine. Selling it at $65 per share, that guy looks like a genius. But buying overpriced shares is a bad bet. You might get lucky, but it is a practice to avoid.

Today Sepracor ended at $27.41 per share, for a market capitalization of $2.94 billion. If you had $2.94 billion, would you buy the company?

What you would get would be trailing revenues of $1.25 billion and net income of $192 million. Dividing net income into market cap is one way to get the PE ratio: 15.3. That is pretty good, a return of 6.5% per year, which is great if profits are growing rapidly.

But yes, there is a major fly in this ointment. Q2 numbers were a disaster. Revenues slumped to $278 million, and net income was a mere $6 million. If that is the picture going forward, this stock is way overpriced. On the other hand if it is a one-quarter, or even 2 quarter blip we are in the midst of a buying opportunity not available since I sold my stock back in 2003.

So what happened? What does Seprecor sell, anyway? You should check out the Seprecor web site, of course; start with the products page. You can see they sell Xopenx for asthma, Brovana for COPD (chronic constrictive pulmonary disease), and Lunestra for insomnia. Note that everything else, their entire pipeline, is in Phase I or preclinical. Which means that they have a lot of time to wait and money to spend, and risk of failure, between them and any of these potential products coming to market. So its nice they have a research program and some candidate drugs, but the real value in the company is the three drugs they already are selling.

The press release of second quarter results tells the story per management. There is a bunch of good news in the press release. Brovana had its commercial introduction. Marketing agreements were made for Lunestra overseas. The company has $890 million cash in its coffers, a very good thing.

But Lunestra sales were up only slightly from a year earlier. Xopenx sales fell from the year before; this was said to be because Medicare and Medicaid reduced what they would reimburse for the drugs usage. Investors beware: government decisions can be a major risk factor for pharmaceutical companies even after they have FDA approval and are marketing drugs.

Brovana sales just began in the quarter, with revenues of $5.5 million.

I would expect revenues and net income to resume growth this quarter; results should be out towards the end of October.

I think at the current price we have a buying opportunity. There should be some growth in the near term from selling Lunestra outside the U.S. and a new income stream from Brovana. Even if sales just get back on an even keel, with profits more like what we saw in the second half of 2006, the stock is priced very nicely.

But Gilead (GILD) or Seprecor (SEPR)? I would still put my money in Gilead. It seems to be on a clearer upward path and its price to earnings ratio, looking forward rather than back, is on par with Sepracor.

Of course you should always look for diversification. If you are looking for several biotechnology stocks to add to your portfolio, both Gilead and Sepracor are worth further investigation.